Blogs

Other Links

RSS Feeds

The Failure of US Fiscal Policy

When it comes to activist fiscal policy, it seems that nothing succeeds like failure. The failure of the economy to respond to previous stimulus measures is always seen as an argument for yet more stimulus, rather than supporting the more obvious conclusion that activist fiscal policy doesn’t work. As Philip Levy notes, if the existing US budget deficit won’t budge its economy, there is nothing the Obama Administration can add that is likely to make a difference:

The Congressional Budget Office projected last week that even without a stimulus package, the federal budget deficit will hit $1.2 trillion this year. That’s 8.3% of gross domestic product. Followers of the late John Maynard Keynes should be thrilled. Such a gap between government spending and taxes was just what he prescribed to stimulate a slumping economy.

And yet the stimulus enthusiasts seem unsatisfied. President-elect Barack Obama argues that this level of stimulus would leave us with shattered dreams and long-lasting torpor. Our only chance is to adopt his plan of $800 billion in additional stimulus spending over the next two years. So $1.2 trillion in deficit spending leaves us in despair, but $1.6 trillion in deficit spending brings prosperity…

there is very little science behind arguments that an additional $800 billion stimulus should do the trick.

Unfortunately, the political imperative is for governments to be seen to be doing something, regardless of whether it works or not.

Thrift is No Paradox

I have an op-ed in today’s AFR refuting the paradox of thrift as a rationale for short-term fiscal stimulus measures. In particular, I highlight the origins of the idea in the discredited ‘secular stagnation’ hypothesis of the1930s. Text over the fold (may differ slightly from edited AFR version).

Monetary and Fiscal Policy Effectiveness in a Globalised World

Alan Greenspan, interviewed in Die Zeit, on the effectiveness of monetary and fiscal policy:

Global forces can now override most anything that monetary and fiscal policy can do. Long-term real interest rates have significantly more impact on the core of economic activity than the individual actions of nations. Central banks have increasingly lost their capacity to influence the longer end of the market. Two to three decades, ago central banks were dominant throughout the maturity schedule. Thus, the more important question is the direction of long-term real interest rates…

The resources of central banks relative to the size of global forces have markedly diminished. We have 100 trillion dollars of arbitragable long-term securities in the world today so that even large movements initiated by central banks have little impact. Until the seventies, central banks and finance ministries were able to hold exchange rates fairly stable. Since then, the ability to intervene in the exchange markets and stabilize the rates has gone down very dramatically. And that is also true for other financial markets. Global forces fostering global equilibrium have become by far the most dominant influence for financial and economic activity. Governments have ever less influence on how the world works.

“Zoos and aquariums are woven into the fabric of American life,” said AZA President and CEO Jim Maddy. “They are viewed by the public as important to the quality of life in their communities.”

Many zoos have their roots in the Great Depression, when the Federal Work Projects Administration (WPA) helped build many zoos across America.

“Zoos and aquariums will deliver incredible value for the Federal government,” added Maddy. “Investment in these institutions will pay-off twice, first in immediate job creation, and second, in the environmental education of our children for years to come.”

The same children can also look forward to paying for them for years to come.

Come to think of it, I also have some ‘shovel-ready’ projects in my backyard that could do with some stimulus.

Fiscal Stimulus Doesn’t Work - Ever

Tyler Cowen suggests the historical record argues against the effectiveness of fiscal stimulus:

it is very hard to find examples of successful fiscal stimulus driving an economic recovery. Ever. This should be a sobering fact…

It’s up to the advocates of the trillion dollar expenditure to come up with the convincing examples of a fiscal-led recovery. Right now we’re mostly at “It wasn’t really tried.” And then a mental retreat back into the notion that surely good public sector project opportunities are out there.

So what you have is the possibility of faith—or lack thereof—that our government will spend this money well.

And that is under “emergency” conditions, with great haste (“use it or lose it”), with a Congress eager to flex its muscle, and with more or less one-party rule.

Another way of looking at this issue is to ask why we would ever need to experience a significant economic downturn if policymakers could effectively smooth the business cycle with fiscal policy.

Meanwhile, Centrebet is offering $1.22 for a local recession by the December quarter 2009. Assuming an 8% bookie’s margin, this implies a recession probability of around 75%. Needless to say, the Treasurer is not happy with betting shops speaking truth to power:

Why Stimulus Measures Don’t Work

I have an op-ed in today’s Age, highlighting the Ricardian and open economy macro arguments against using fiscal policy for demand management:

From the perspective of national saving, it makes no difference whether an increase in government spending comes out of the budget surplus or whether the government goes into deficit and borrows from capital markets. Either way, the government is saving less.

But this doesn’t mean that households will follow the government’s example. In fact, households are likely to save more in anticipation of a higher future tax burden due to the reduction in government saving…

Demand management is best left to the Reserve Bank and monetary policy, which has already responded aggressively to a slowing economy.

The sharp decline in the Australian dollar exchange rate is also a powerful stimulus to net exports, but any boost to demand from fiscal stimulus will also have the perverse effect of putting upward pressure on the exchange rate, reducing net exports. In an open economy, there is no free lunch from fiscal policy.

Fiscal policy still has a role to play in supporting economic growth, but it needs to focus on long-run structural and supply-side issues not short-term attempts at rigging aggregate demand.

This means rewarding labour force participation, not encouraging welfare dependence. Throwing more money at pensioners and families will not boost economic growth in the long-run and may not work as the government intends in the short-run.

In The Australian, Henry Ergas makes a similar argument against proposals to use superannuation contributions as a macroeconomic stabilisation instrument:

Consumption decisions are shaped not by transient changes in income but by expectations of income going forward, a proposition known as the permanent income hypothesis. A short-term reduction in compulsory savings, soon reversed and followed by a sequence of rapid increases in mandatory contributions, amounts to a pre-announced reduction in disposable incomes. As households respond to the news that their disposable incomes will fall once the temporary cut is reversed, consumption is likelier to decline than to increase.

My Age piece may have fallen victim to a which-hunt. This line should read:

‘The household saving ratio has already surged from 1.3% in the June quarter to 3.9% in the September quarter. This implies that taxpayers squirreled away their 1 July tax cuts, which came at the expense of the budget surplus rather than cuts to government spending. ‘

Saved Not Spent: Ricardian Equivalence Negates Fiscal Stimulus

Westpac crunches the numbers on the household income account, with some predictable results:

All up, the total fiscal boost to household disposable income in Q3 was about $1.9bn. This was mostly due to $7.1bn in income tax cuts, which equates to $1.8bn a quarter. The boost appears to have done little or nothing to stimulate consumer spending in Q3. Indeed, with aggregate household savings rising by $4.4bn in the quarter, the implication is that, in aggregate, households saved all of the windfall and then some. Most of the savings appears to have gone towards paying down housing debt.

The national accounts figures and RBA credit data imply that households injected an enormous $7.5bn into their housing equity in Q3, most of which would have been via paying down principal. This is only the third net equity injection recorded since June 2001. It is easily the largest ever in dollar terms and is the biggest as a proportion of income since 1998Q3. If Q3 is a guide and households remain as deeply concerned about reducing their debt levels in the months ahead, the implication is that there will be little or no boost from policy stimulus in Q4.

Westpac nonetheless thinks Q4 might be different, on the basis that saving all the stimulus in Q4 would be ‘too extreme’, but unprecedented times are likely to induce unprecedented responses as households anticipate a higher future tax burden.